Written by Sachin Singh, pursuing Diploma in Cyber Law, Fintech Regulations and Technology Contracts offered by Lawsikho as part of his coursework. Sachin is an experienced Software Engineer and wants to pursue a career in Tech Law after completion of his LLB course. Currently he is in his 2nd year of Law school and completing his education from of New Law College, Mumbai.
Introduction
Financial technology companies, also known as Fintech companies, are the brand-new industry in Indian revolutionary digital market. Fintech by definition is a company which eases the access of financial product with the use of technologies. These companies have grown at a tremendous level in the past 3 years due to the lack of efficiency of traditional banks and NBFC’s. The financial sector had seen a variety of companies like Fintech, start-ups, e-commerce and technology firms evolving post-2008 financial crisis. Fintech’s have a strong business model, innovation to solve problems, use of advanced technologies to enhance and disrupt the financial services.
In past few years, the Fintech companies have able to penetrate in the Indian market and provide services to such categories of the population who were not addressed by traditional banks and NBFC’s in past many decades. Fintech provides the solution in a different way for financial inclusion in areas like micro level financing, digital payment, insurance services etc. By the government initiative of policies like digital India, financial inclusion of marginal and outcasted people (Jan Dhan Yojana), direct money transfer etc. It has created a good foundation for Fintech companies to innovate new methodology for financial inclusion and business growth.
Fintech companies create products which are of low cost but high in quality service directly given to people under a variety of business model like B2B, B2P, and P2P etc. The cash transaction is a big problem in any country because some part of the whole cash transaction is not informed to the Tax authority leading to loss of revenue which not good for emerging countries like India, Brazil etc. Fintech has potential to provide transparency in governance as most of the transaction are done in digital form which afterward reduces the usage of cash in the market. Fintech helps in growth of the cashless market. The digital form of a transaction can be monitored by regulators like the Reserve bank of India.
Fintech is boosting India to become the next financial hub like Singapore, London, New York with the help of technologies, unserved Indian population, and government policies. It is only second to China with an adoption rate of 52% with this figure it has still not achieved its tipping point. Fintech has been recognized as digital payment companies by Indians. But they are more than just a digital payment company they are Fintech’s which evolved in digital wealth management, educational sector, robotic automation, smart contracts, data analytics etc. Fintech has a double chance of producing jobs either directly or indirectly with the same amount of investment as in manufacturing companies.
Fintech requires investment for hiring software engineers, advance technology implementation, market researcher, innovative business model etc. India can be the largest Fintech hub in the world if it gets a robust Fintech ecosystem. A Fintech ecosystem means having a favorable environment, regulatory policies, Technical staff, monetary investment etc. India is the largest producer of STEM background employees which is the biggest advantage for Fintech. To have a successful Fintech ecosystem, we need a market where participant identifies problems and convert this problem into opportunities and finally towards business, engage people of different expertise and share development across all communities like pharma, automobile, Hospitality etc. There are still many segments like Agriculture, development of tier 2 or tier 3 town into smart cities etc. which are open to Fintech which can provide a range of benefit.
Top 5 developments in Fintech law
Aadhar Verdict impact on Fintech
Aadhar card having 12 digit number has been a key pointer in India’s largest financial inclusion policy i.e. Jan Dhan Yojana where the bank account of all people linked through Aadhar. But on the recent judgment of the Supreme Court of India, Section 57 of the Aadhar Act had been struck down. Section 57 gives power to both State Government and private bodies like telecom and bank etc. to use Aadhar number of an individual for any purpose. Supreme Court verdict has shaken many Fintech’s as their business model were based on e-KYC which helps in reducing the operational cost and time.
e-KYC (electronic- know your customer) which was widely used by Fintech to provide loan, payment, Mutual funds, insurance etc. Basically, the customer had to provide Aadhar number online while registering with any Fintech service provider. For processing an e-KYC the Fintech had to shell out approx. Rs 15 which earlier when paper processing was around Rs 100. This will now escalate by 10-15% affecting both business and customer. A Loan disbursement company would credit loan into the applicant’s account within 24 hours with this verdict it is going to impact on delivery time.
This verdict has also impacted Banks and telecom service provider like Bharati Airtel, Vodafone etc. Only based on fingerprint the customer would instantaneously get sim card or opens his bank account. It has also impacted the government which was able to plug leakages in subsidies provided under social welfare programme. It directly transferred monetary subsidiary into the bank account which is linked through the Aadhar card of the targeted audience.
Many Fintech had been providing this service to many state government, Municipal Corporation, central government etc. are now in dilemma on how they would be able to achieve the same result. There is still a ray of hope given by the law minister that they would come up with some new rules and regulation. Even RBI is trying to make new rules which would help in simplifying the authentication process.
The Fintech companies can use voluntary option instead of forcing the customer to comply with the Aadhar authentication process. The positive side of this verdict is that the Fintech would now require to innovate business model keeping consumer privacy policy on how they would collect, use and store the data.
Data Localisation
In April 2018, RBI has issued a circular of Storage of Payment System Data where it has a mandate to all intermediaries like master card, visa etc. and payment Fintech companies like Paytm, WhatsApp payment, google pay etc. to store the data in India.
In July 2018, Justice B.N. Srikrishna committee on data protection draft law had a recommendation where there should be a copy of all data stored locally and a part of that data, which are critical data, they should be stored and processed locally.
These rules have come in the background of data manipulation done by companies which store and analyze data like Facebook, Google etc. The manipulation as done in elections of the USA or Brexit referendum has impacted a large number of people. The companies like Facebook collect a huge amount of data from all over the world and they themselves do data profiling to identify the behavior pattern of an individual person so that they can push their products. Facebook even managed to supply critical data to analytical companies like Cambridge analytics based in the UK which had a vital role in manipulating peoples vote in Brexit referendum. It had impacted Indian citizens as well but in different ways.
This directive by RBI, states that companies processing data, gathering of any insight or doing user profiling are to be done within the boundary of the country. It has the impact on all companies which are based outside India and domestic companies which are backed by US giants or foreign investment like Paytm(backed by Softbank, Alibaba, and Berkshire Hathaway), Google pay which is subsidiary of Internet giant Google.
The guidelines made provision for companies which are involved in a foreign transaction can store data in foreign countries. Companies like InstaReM, which is a cross border remittance company will now have store data in India as well as in foreign entities. This guideline gives an advantage for domestic payment companies like Paytm which has been in support of data localization. The foreign payment companies like Google pay, WhatsApp pay, and Amazon pay are still at a nascent stage and face difficulty to compete in the Indian market.
Many Fintech and Internet giants have raised their concern over the guidelines. It seems to them as the protectionist policy which can be followed by other countries. It has a domino effect on domestic Fintech start-up which is growing to compete in the global market and large IT service firms like TCS, Wipro etc. which process a huge number of foreign data in India.
In countries like Russia and China, they have a stringent policy on data localization. They allow data followed by compliance to a lot of rules and regulations and if found any wrong done by the companies they are heavily penalized. European Union general data protection regulation (GDPR) has not to mandate any provision of data localization instead they have restricted flow of data to the countries having strong data protection framework.
Data localization circular by RBI has two-fold benefits, first it will help security agencies to have faster access if data is in India they don’t have to wait for request approval and sending of the report from a foreign country where data is stored. It will also help in tracking terror funds and understand the pattern of disbursement to different terrorist organizations.
Secondly, the Government will apprehend about the critical information data of the citizen is used in what manner and directly and indirectly by whom. It can take action within time and can secure the privacy right of its citizen.
Effect of New FDI rules in E-commerce on Online E-commerce platforms
In the last month of 2018, the government of India has brought a major change in its FDI rules in e-commerce which has come into force from 1st February 2019 has created a ripple effect among Fintech specially those who are online marketplace based model of e-commerce for buying and selling goods and services like Flipkart, Amazon etc.
It has put a restriction on companies like Amazon which have been selling goods and services on their platform through other companies like Appario Retail in which it holds more than a 25% stake. The government has explained that it has given 100% FDI in e-commerce for B2B i.e. Business 2 Business model and not in inventory based business model.
Inventory based business model is in which a logistics company is a wholly subsidiary of another company which is Joint Venture between an e-commerce company and some other company. This logistic company fulfills all demand for online e-commerce company indirectly raising revenue for it.
For example, Cloudtail India Pvt Ltd which is known to be the biggest seller of Amazon. Prione business services hold 99.99% in Cloudtail and this Prione business services is a joint venture of Amazon and Infosys co-founder Narayan Murthy’s catamaran advisor. Amazon holds 49% and Catamaran holds 51%.
In an inventory based business model, the e-commerce online platform always projects the retailer in which it has the interest. It provides quality services, better product rating, less costly compared to other sellers on the same platform. This kind of practice creates discrimination among other seller’s especially small seller of tier 2 and tier 3 towns/cities. Through this FDI rule, the government has clear banned this kind of seller from selling products on the online platform of e-commerce Company or its group companies which have 25% or more in it.
The new FDI rule has a provision which has restricted e-commerce giants like Flipkart and Amazon etc. from selling any product on their platform under their own label. The government has said that e-commerce companies have to maintain level playing and should not influence directly or indirectly the sale price of any goods and services.
No Seller can sell any exclusive product on any e-commerce platform. This has been a practice of many mobile entities like Samsung, One plus etc. having a tie-up with the sellers like Cloudtail, Retail Net etc. which would have flash sell or exclusive sell either on Flipkart or Amazon. This kind of selling product pushes revenue of e-commerce Company by many folds.
The policy mandates E-commerce entities to provide services in a “fair and non-discriminatory manner” to all sellers. Services include fulfillment, logistics, Warehousing, advertisement, and payments. The cashback offer given to buyers by the e-commerce or its group companies have to be fair.
In the Marketplace based online e-commerce platform, the seller will be responsible for the guarantee/warranty of all goods and service sold by them. At one end it brings a ray of hope for small, independent or MSME sellers but on other ends, the customers of Indian market who mostly rely on huge discounts, cashback offers etc will be impacted in a negative way.
The E-commerce have to provide a report of a statutory auditor to RBI on every 30th September of every year for preceding financial year. This report would show that they are complying with new FDI rules.
RBI Crypto Currency Ban
Another regulatory action on Fintech industry came with declaring cryptocurrency as an illegal tender by RBI. There had been statements given by RBI and Finance minister clearly that they are in not support of cryptocurrencies.
Cryptocurrency is a digital currency which uses encryption technology to regulate the generation of currency unit and transfer of funds without the need of any central bank. RBI in its April circular said that all entities which are regulated by it shall not deal in virtual currency i.e. cryptocurrency and crypto-assets. It directly impacted approx. 50 lakhs Indian who have invested in virtual currencies. Bitcoin exchange alone is near $2 billion. The reason for it is that this type of transaction raise concern on money laundering, consumer protection as it is not regulated and market integrity.
Many Fintech companies like Coinbase, Zebpay have been impacted by this policy. Since any individual would be requiring to do the monetary transaction through a bank which has been bounded not to do the transaction. So there can be no transaction on their platform if Indian banks don’t give money for trading in cryptocurrency. This regulation has not only to impact cryptocurrency like Bitcoin or Ethereum in domestic market but also at the global level. YES bank has circulated to its account holder not use the debit card, credit card, internet banking or mobile banking to do any trading in virtual currencies.
In one of the incident, Unocoin based in Bengaluru had kept India’s first Bitcoin ATM for buying and selling bitcoin in a mall. This ATM was not in operational mode but still in beta testing. The police arrested a person and seized ATM and all bitcoin worth of Rs 1.08 lakh. The Unocoin founder defended that it is not illegal tender but not legal tender which means the person can invest in this on his own risk.
The cryptocurrency uses blockchain technology, distributed ledger technologies which are new in the financial sector. Even though the Indian government and regulatory body are against cryptocurrency but they are highly inclined towards blockchain and distributed ledger technology.
RBI’s technology research unit, Institute for development and research in banking technology (IDRBT) is researching how to use blockchain in the banking sector. The blockchain is the most secure transaction technology compare to others.
Many crypto-based Fintech have been under pressure to move their base or close them. But at the same time, there has been an enormous increase in demand for blockchain Fintech. Every organization is investing a lot of money in blockchain R&D. State government like Andhra Pradesh has inked an MOU with Fintech companies to move its all department data related to property titles ownership into blockchain ecosystem. Till now 1, 00,000 record added in the blockchain system. With the support of government and demand by other sectors for blockchain, the ecosystem would push Fintech industry to 60% by 2025.
Ban on Online Pharmacies
E-pharma is building industry in the Indian market where people can get home delivered of any type of medicine which can be prescribed or non-prescribed. E-pharma like Medicare, Netmeds, Pharmeasy etc have created the next level of medical supplies to the customer through cashback, multiple offers, and most important is scheduled home delivery. This kind of service was never provided by a traditional chemist shop.
With Recent judgments, India’s Nascent industry e-pharmacies have got stuck between whether they are banned or not due to multiple judgments given by a double bench of Delhi high court and a single bench of Madras high court which say online pharmacist cannot sell any or prescribed medicine. Whereas the double bench of Madras High court has stayed order of its own single bench and left it on the government to come up with notification.
The legal issue arose due to the deficiency in Drugs and Cosmetics Act, 1940 which says that schedule X and Schedule H drugs cannot be sold without a prescription. It does not say about the online sale of such schedule drugs. Information Technology Act, 2000 is also silent on online pharma.
Before 2013, the online pharma companies were running the business without any regulation or license. There had been few incidents where it was linked that online pharma is run by an organized criminal network. But without any legal framework for online selling of medicines, it has been difficult for the government to regulate them. Online medicine sold to millions of people without any regulation will put their lives on risk. For traditional chemist shop they have stringent rules under Drugs and cosmetic act they have to sell medicine under prescription given by the doctor and should be given under the supervision of a chemist.
The petitioner who is against online pharma has stated that these drugs are highly potent any misuse or abuse of it can damage the life of an individual. Since the internet has gone to a rural area the people are not well educated can get addictive to medicines which are easily available to them.
Even the prescription is not needed in some e-pharma and in few they only verify through the photo of prescription there is no actual verification of it. Currently, there are 250 online pharmacies minting around $140 million from the Indian drug market. Netmeds which has the largest share in the online market is raising a series of funding from international investment houses.
E pharma is a very good business model it should be regulated as it has a very huge impact on the Indian market. The customer like senior citizens who are not able to go chemist shop and they tend to forget repurchase there medicine. Traditional pharma is controlling around 95 to 98% market whereas online pharma is just around 1 to 2 %.
With the advance of technology, there are ample opportunities for Fintech in the pharma sector. Even the government is trying to provide medicine to everyone through Jan Aushadhi programmes which promoting generic medicine. Many people in rural area are not getting proper medicine which leads to loss of life.
The government needs to come up with notification since there is already made a draft on the regulation of online pharma. Strong regulation and promotion of online pharma would help it to grow at a faster rate which would give healthy competition to the traditional chemist and the customers would be enjoying the benefits from it.
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